NASSCOM, the technology industry body, has valued the Indian IT industry at around $253.9 billion for FY24 in its recent strategic review findings. Given the macro uncertainty, with nearly 50% fall in overall tech spending world over and a 6% decline in tech contracts, the Indian IT industry is expected to grow a modest 3.8% year-on-year from $244.6 billion in FY23, adding just over $9 billion in incremental revenue.

Large tech services companies that provide annual revenue growth guidance such as Infosys and HCL Tech, expect to end FY24 with 1.5-2% and 5-5.5% growth, respectively. Other large companies are staring at flat growth this fiscal or revenue decline.

In contrast, mid-cap and small-cap companies have a different story to tell. While it wouldn’t be an apple-to-apple comparison between both, given the vast revenue gap between the top six and mid-tier firms, the accelerated growth rates of mid-tier firms post Covid has seen price-to-earnings (P/E) ratio increase and reward investors handsomely. With size not dragging them down, sectoral focus and agile operations give them an edge over large IT firms in moving faster as technology becomes a big leveller in the age of artificial intelligence (AI).

Three mid-tier IT services companies — L&T Technology Services, Persistent Systems and Coforge — joined the milestone billion-dollar revenue club in FY23 on the back of accelerated double-digit growth. This year, as large legacy firms struggled with discretionary projects taking a back seat and deal conversion cycles getting stretched, besides U.S. macro concerns and industry specific slowdown in banking and financial services, mid-tier firms were able to find a sweet spot to operate. “Mid-tier players had a lot more deals in the $5-20 million range and that works favourably for them because they can provide the right amount of management bandwidth to those deals,” says Apurva Prasad, vice president, institutional research at HDFC Securities. As IT buying gets democratised with decision-making extending beyond the CTO and CIO’s office over the past three-four years, there is greater opportunity for mid-tier companies, which was not the case earlier, says Prasad.

Unlike the past where the size of a company was an indicator of its ability to execute a project, today vendors who can quickly adapt and build have become critical. “Competition now is going to be determined by how fast you build capabilities, how fast you build differentiations. And the one thing that’s going in favour of mid-tier is agility, especially when they are building sectoral focus,” says Debjani Ghosh, president, Nasscom. Be it through buy or build, many companies have acquired talent from much larger companies to strengthen their practice or bolster offerings. In October 2023, Mphasis acquired Silverline, a digital consultancy firm for over $132 million to strengthen its Salesforce practice. The acquisition brought not just capability but also Salesforce customers, and the revenue from Silverline was a little over $15 million in Q3FY23.

“We’ve done a fairly thorough analysis of which customers we are likely to retain, because we operate in slightly different market segments. We are more focused on the enterprise segment, while they had a combination of enterprise and mid-market,” says Nitin Rakesh, CEO, Mphasis in the earnings call. In November 2023, auto sector-focused KPIT Tech announced acquisition of a 13% stake in Swiss company N-Dream, a Cloud-based game aggregation company for €3 million, foraying into in-car gaming. “If we think someone has done something smarter than what we do, and if it will take us more time to develop such technologies and we see a right fit we will do it,” says Kishor Patil, CEO and MD, KPIT.

Mid-tier companies have been dipping into the management talent pool from diverse sectors to strengthen leadership in focused areas. In late 2022, Birlasoft brought in Angan Guha, who earlier was the CEO for the Americas 2 Strategic Market Unit at Wipro as its CEO and MD. In December 2023, Persistent Systems got Rajiv Sodhi, former COO of Microsoft India, to lead their hyperscaler business and strategic alliances, and Ayon Banerjee, former MD and partner at BCG, as its chief strategy and growth officer.

As engaging with hyperscalers (large Cloud service providers) is becoming critical in the current digital business environment, mid-tier IT companies have been deepening partnerships with hyperscalers for capacity expansion. Recently, L&T Technology Services (LTTS) announced a partnership with chipmaker and AI major NVIDIA to develop specialised software in the medical devices sector, especially in endoscopy, giving LTTS access to the U.S.-based tech major’s full-stack edge AI computing platform. Persistent Systems, meanwhile, announced a multi-year collaboration deal with Amazon Web Services (AWS) enabling the adoption of generative AI offerings such as Amazon CodeWhisperer and Amazon Bedrock. The access to additional resources of AWS is likely to help it scale up its generative AI proofs and offerings, while also reducing go-to-market time.

Valuations and Premium

While the IT industry is hopeful of growth coming back in the next 12-18 months, compared to large-cap companies, mid-cap stocks have been commanding high premiums, which some industry experts believe are exorbitant valuation. Prasad points out if one traces back to pre-Covid levels or 10 years before that, the growth premium of mid-cap firms had been about 1.5 -2 percentage points over Tier-I IT companies. “This gap has gone as wide as 7-8 percentage points now, which is what played out in FY23, where overall industry growth rate was in low teens and mid-cap grew at about 20%” he says. In FY24, where large-caps’ topline growth will be in low single-digits, mid-caps will be doing double-digit growth, he adds.

While these higher forward valuations of the company may be a shareholder’s delight, much will depend on sustaining growth. The current PE valuations at lower growth are not sustainable, says Mukesh Kochar, national head of wealth, AUM Capital. “Even if there is a 20-25% growth, you cannot trade at 60 or 70 P/E. Pricing is no doubt on the higher side and we are very cautious at this point of time to add any of these companies,” adds Kochar.

As technology adoption evolves, large IT services companies are competing with insourcing by global firms as they expand their capability centre footprint. On the other, mid-tier firms are successfully competing and winning deals where tier-one companies also bid, and that is what is reflecting in the growth. “So, what large-cap IT was doing to some global majors over the last 10-15 years is what mid-tier are doing to the larger ones, in terms of market share,” concludes Prasad.

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